Presidential tweets accusing Amazon of hurting small retailers, not paying enough taxes and taking advantage of US Postal Service caused some wild fluctuations in its stock

Google also dropped almost 15% in the first week in February as questions arose about threats to its advertising business

Index Funds and ETFs

Flows of capital into and out of the fund maintain proportions (capitalization weighted)

Thus, stock price movements of the very largest companies have a disproportionate impact on the volatility of the ETF

Large inflows mean large, non-price-sensitive buy orders which can exacerbate volatility of the underlying stocks. The reverse is true when investors sell the funds and the component stocks must be sold on short notice

Interest Rates and Inflation

Interest rates have been unusually low both because of Fed policy and because inflation has been low by historical standards for several years

Now the Fed is raising short-term rates and letting its bond portfolio self-liquidate as bonds mature

Withdrawal of the Fed’s capital from the bond market puts upward pressure on interest rates. Inflation is beginning to tick up because of economic growth and very low employment, and this also pushes interest rates higher

Rising interest rates act as a headwind for stock and bond prices. The impact is direct for bonds. A 10-year, 2% bond issued at a price of $100 falls to $83.65 if comparable bonds soon become available with 4% coupons

Higher interest rates generally lead to lower P/E ratios

Political Climate

Polarization of Congress and the determination of the president to bring change to Washington have injected a large dose of uncertainty into the stock and bond markets

Concerns around the current political climate and ‘what might be’ is not helpful for business planning

War with North Korea and other apocalyptic events are not impossible, but they seem so unlikely that we do not dwell on them in picking stocks and planning investment strategy

Promised regulatory relief has been welcomed by the business community. Budget hawks have also cheered the “streamlining” of various government departments and agencies. We suspect that actual rule changes and compliance cost savings will be less than anticipated, but from many individual companies’ point of view, these are positives

Trade Issues

Tariffs and other impediments to free trade have not worked well in the past and seem particularly unwise given today’s complex global supply chains

Outcomes of “Art of the Deal”-style bluster and backtrack negotiating tactics are hard to predict but seem certain to complicate life for many businesses, farmers, workers, consumers, and investors

Tax Code

Changes to the tax code are significant. While it arguably benefitted a different segment of the tax paying population than advertised, it has had a major positive impact on much of corporate America

Ironically, Berkshire Hathaway, whose chairman disagreed with the structure of the cut, was probably the biggest single beneficiary, with roughly $29 billion in one-time tax savings in 2017 plus ongoing savings due to the lowered corporate tax rate

Potential downside of the cut is that, in combination with a less-than-conservative spending bill, the impact on the growing budget deficit may well turn out to be inflationary

Our Game Plan

Near-term outlook for the “market” is not the same as the outlook for our next 3-5 years of returns

Historically, after a long bull market, we generally see a period of sideways market “consolidation”

Over the past 9 years, company earnings have grown, and the valuation placed on those earnings (P/E) has also grown

It would be perfectly normal to see a period of years in which earnings continued to grow but P/E ratios shrink. The result would be a market that generally moves sideways but with plenty of short-term volatility

Our approach is to take aggressive positions when investors are fearful, and stocks are very cheap; to hold them as markets recover; and to harvest the gains when an overvalued market makes stocks relatively unattractive

This is not an environment in which we expect oversized absolute gains, but we are hopeful that it is one in which we can protect capital in the near term and set up the portfolios for very good returns over the next 3-5 years